The EMA argued that, as a result of Brexit, and as a matter of EU law, it would lack capacity to make use of the premises or perform its obligations under the lease, and therefore the lease was frustrated under English law. The judge rejected the EMA’s case that it would lack such capacity under EU law, and in any event found that an intervening lack of capacity under foreign law, after the contract had lawfully been entered into by the relevant foreign party, would not be relevant to questions of frustration under English law.

Overall, the decision illustrates the uphill struggle that is likely to face a party seeking to establish that its contracts are frustrated as a result of Brexit. The EMA is in a fairly unique position, as a European agency with good reasons to be located in an EU member state – even if the judge rejected its case about a broader lack of capacity to make use of premises located elsewhere – and it could not succeed in establishing its case on frustration. In principle, however, the decision leaves open the possibility of establishing frustration where a party is able to show that, as a result of Brexit, it will be deprived of all or substantially all of the benefit of a contract, or that it will simply not get what it bargained for, rather than performance merely becoming more onerous or inconvenient.

The EMA is reported to be studying its options for appeal, so this may not be the last word on the issue.

Background

The defendant, the EMA, is an agency of the European Union. The claimants, Canary Wharf, are the EMA’s landlords in relation to a 25 year lease of office premises in London dated 21 October 2014. By a letter dated 2 August 2017, the EMA wrote to Canary Wharf stating that it would treat Brexit (if and when it occurred) as frustrating the lease.

In response to that indication, Canary Wharf issued the present proceedings seeking a declaration that the UK’s withdrawal from the EU and/or the relocation of the EMA would not cause the lease to be frustrated, and that the EMA would continue to be bound by all of its covenants and obligations including the payment of rent.

The EMA’s case was that the lease was frustrated for a number of reasons, including because, as a matter of EU law, it could not occupy the premises or make profitable use of them (eg by exercising the right of assignment contained in the lease), and would have no power to meet its obligations under the lease including the payment of rent.

Canary Wharf disputed the factual basis for EMA’s case, as regards the effect of Brexit on the EMA’s powers, but in any event argued that none of the grounds put forward, even if established, would be capable of frustrating the lease.

Decision

The High Court (Mr Justice Marcus Smith) held that the lease would not be frustrated even in the event of a “no deal” Brexit – which he assumed merely for the purposes of determining the issue, as that was the scenario in which the consequences of the UK’s withdrawal from the EU were at their “most stark”.

Having reviewed the key authorities on the doctrine of frustration, Marcus Smith J said that whether a contract is frustrated depends upon a consideration of the nature of the bargain of the parties when considered in the light of the supervening event said to frustrate that bargain. Only if the supervening event renders the performance of the bargain “radically different”, when compared to the considerations in play at the conclusion of the contract, will the contract be frustrated.

The EMA put its case on frustration on two bases:

Its primary case was that the lease was frustrated by supervening illegality, ie that performance of the lease by the EMA had become illegal in the sense of it being ultra vires the EMA.

It argued in the alternative that there had been frustration of a common purpose, ie that the lease was no longer of any use for the contractually contemplated purpose, which it said was to provide a permanent headquarters for the EMA for the next 25 years.

Frustration based on supervening illegality

(i) Did the EMA lack capacity in the relevant respects?

The judge noted that the EMA did not contend that it lacked capacity to enter into the lease. Its case raised, instead, what the judge described as “the novel question of a supervening incapacity to act”. Questions of the EMA’s capacity were to be decided under EU law, but the judge declined the EMA’s submission that the question should be referred to the CJEU for a preliminary ruling.

The judge concluded that, in the event of a no deal Brexit, the EMA would retain capacity to deal with immovable property in the UK, despite it no longer being an EU member state, and that the EU itself has the capacity to maintain the headquarters of its agencies in a non-EU country. He accepted that there were many and good reasons why the EU would choose not to do so. However, he said, those reasons had nothing to do with the capacity of either the EMA or the EU. The judge therefore rejected the EMA’s contention that it would lack capacity to continue performing its obligations under the lease, including the payment of rent post-Brexit.

The EMA’s case on supervening illegality therefore failed.

(ii) If the EMA lacked capacity under EU law, was that relevant?

Despite his conclusions summarised above, the judge went on to consider the question of frustration by supervening illegality on the assumption that the EMA’s contentions regarding its capacity were, contrary to his conclusions, correct.

In those circumstances, the question arose as to the impact on the English law of frustration of supervening illegality arising under a foreign law (here EU law). The judge noted that, generally speaking, the validity and enforceability of a contract governed by English law is not affected by the question whether the contract would be valid or its performance lawful under the law of another country. As he put it, the English law of frustration discounts illegality arising under a foreign law. There are certain limited exceptions, such as where the contract is to be performed abroad and performance becomes illegal under the law of that country, in which case the contract may be frustrated by such supervening (foreign law) illegality.

However, the question was whether there was a further exception where, under the law of the place of incorporation of one of the parties, that party no longer has capacity to continue to perform its obligations under the contract. The judge described this as an extension to the English law of frustration, and concluded that it could not be so extended. The case law, he said, shows is a clear line between the capacity to enter into a transaction, where English law will have regard to the foreign law of incorporation or domicile, and supervening events (including, he considered, in relation to capacity) which affect contractual liabilities already assumed, where English law will not have such regard.

Accordingly, even if the EMA did lack the capacity to continue performance of the lease by reason of supervening illegality under EU law, this would not be relevant for the purposes of the English law of frustration.

(iii) Would the supervening illegality be capable of frustrating the lease in any event?

The judge went on to consider whether, if he was wrong on the above points, the supervening illegality relied on by the EMA would amount to circumstances capable of frustrating the lease.

Having reviewed relevant case law, the judge said that for supervening illegality to frustrate a contract, it must remove all or substantially all of the benefit that one party receives from the contract. In the present case, if the EMA were correct in its contentions regarding its capacity under EU law, and if this were relevant to frustration under English law, the judge said it would follow that the lease would be frustrated, as the EMA would be unable to use the premises at all post-Brexit.

Further, if the EMA were correct as to its lack of capacity save as regards the ability to continue to pay rent under the lease, its case on frustration would still hold good, as the EMA would be deprived of substantially all benefit from the lease but remain obliged to pay the rent.

(iv) Would the EMA’s case fail in any event as the frustrating event was self-induced?

However, even if the supervening illegality were capable of frustrating the lease (as per the judge’s conclusions at (iii) above but contrary to his conclusions at (i) and (ii) above), the judge would in any event have concluded that the lease was not frustrated as the frustrating event was self-induced.

As the judge put it, the EU could have done more than simply ordering the EMA to relocate to Amsterdam, for example by legislating for the winding down of the EMA’s position in the UK. If the EMA lacked capacity to deal with the lease as a result of the EU’s failure to make such provisions, that meant it was self-induced.

The judge rejected the EMA’s argument that the acts of the EU as a whole could not be attributed to the EMA for the purposes of self-induced frustration. In essence, he said that the EMA could not rely on the EU’s acts (in compelling its withdrawal from the UK) as frustrating the lease, while at the same time arguing that those acts were irrelevant for the purposes of self-induced frustration.

Frustration of a common purpose

The judge adopted the approach described by Rix LJ in The Sea Angel [2007] EWCA Civ 547, namely that the application of the doctrine of frustration requires a multi-factorial approach, with the factors to be considered being:

“the terms of the contract itself, its matrix or context, the parties’ knowledge, expectations, assumptions and contemplations, in particular as to risk, as at the time of the contract, at any rate so far as these can be ascribed mutually and objectively, and then the nature of the supervening event, and the parties’ reasonable and objectively ascertainable calculations as to the possibilities of future performance in the new circumstances”.

Interestingly, the judge concluded that Brexit was not reasonably foreseeable at the time the agreements for lease were entered into in August 2011 (which the parties agreed was the relevant date for these purposes, as at that point the parties were committed to enter into the lease).

However, he gave fairly short shrift to the argument based on common purpose, finding that there was no common purpose beyond the purpose to be derived from the terms of the lease itself. Outside those terms, the judge commented, the parties’ purposes were not common, but divergent. The EMA was focussed on bespoke premises, with the greatest flexibility as to term, and the lowest rent. Canary Wharf was focussed on long-term cash flow, at the highest rate, and to ensure that it was protected in the event of the EMA’s departure from the premises for whatever reason. The judge’s conclusions were supported by the absence of a break clause and the provisions in the lease allowing assignment and sub-letting.

In short, the judge found that the supervening event, was in reality the EMA’s involuntary departure from the premises, due to circumstances beyond its control. That involuntary departure was not merely envisaged but expressly provided for in the lease, and there was no common purpose outside of the lease. The EMA could not say this was not what it bargained for.

I’m a commercial property surveyor specialising in rent review and business tenancy advice for landlords and retailers. I encounter leases whose alienation criteria for what constitutes reasonable refusal of the landlord’s consent for assignment includes the requirement for a person/entity having to be ‘resident’ in the EU. So far, the effective dates for my clients’ purposes predate the withdrawal in March 2019 but not long now before the tenant’s interest could in the event become unassignable.

Herbert Smith Freehills LLP is authorised and regulated by the Solicitors Regulation Authority.

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